Why Merck Could Go Even Higher

Shares of Merck (NYS: MRK) hit a 52-week high on Friday. Let's take a look at how it got there and see whether clear skies are still in the forecast.

How it got hereThis year has shaped up to be the worst year on record for brand-name drug expirations in the pharmaceutical industry, with $33 billion worth of drugs at risk of losing marketing exclusivity. Merck, and much of the sector, are in line to lose key drugs, although the magnitude of those losses varies by company.

Merck is set to lose patent exclusivity on asthma treatment Singulair, which accounted for 11% of total sales last year. While there's no way to construe this as "good" news, the amount of revenue risk is peanuts compared to what other pharmaceutical names are encountering.

Forest Labs (NYS: FRX) lost exclusivity on its blockbuster depression drug Lexapro in March -- a drug that contributes to about half of Forest's annual sales -- and will lose its other significant sales producer, Namenda, in 2015. Pfizer (NYS: PFE) lost the best-selling drug in the world, Lipitor, to patent expiration just months ago. Lipitor was responsible for roughly 15% of Pfizer's annual sales. Eli Lilly (NYS: LLY) , which we examined last week, has three-quarters of its revenue at risk of generic competition over the 2010-2017 time frame.

But, enough with the negativity! Merck is hitting new highs due in part to the company's first dividend hike in seven years (which happened last November) and the fact that it plans to file for approval for multiple new drugs this year. A current yield of 4.2% combined with its pipeline diversity and stability appears to be just the recipe that investors ordered.

With the exception of Bristol-Myers Squibb (NYS: BMY) , the nominal (non-dividend-included) returns on pharmaceuticals haven't been very appealing over the past five years.

Company

Price/Book

Price/Cash Flow

Forward P/E

Dividend Yield

Merck

2.2

9.6

10.5

4.2%

Pfizer

2.0

9.5

9.2

3.9%

Eli Lilly

3.3

6.7

9.7

4.7%

Bristol-Myers Squibb

3.5

12.2

15.7

3.9%

Source: Morningstar. Yields are projected.

Make no mistake about it, these pipelines are undeniably profitable, but that doesn't mean their near-term growth is anywhere near assured.

Merck's near-term hit from Singulair shouldn't linger too long as its diabetes portfolio -- namely, Januvia and Janumet -- is on fire. In addition, the FDA approved Zioptan to treat elevated eye pressure associated with glaucoma. These may seem like baby steps when it comes to replacing Singulair, but Merck is figuring out how to grow organically.

Bristol-Myers has taken a completely different route. It took a huge gamble by purchasing Inhibitex earlier this year in an attempt to buy its way into the highly lucrative hepatitis C market. Bristol-Myers also lost patent protection on clot-fighting drug Plavix last month, which is bound to weigh on near-term results.

Both Pfizer and Eli Lilly have yet to figure out a way to get their growth machines working again. Eli Lilly's best hope is Alzheimer's drug solanezumab, which has phase 3 data coming out next quarter. However, success is anything but guaranteed. Luckily for Eli Lilly shareholders, its patent cliff doesn't come all at once, but it nonetheless creates a seven-year-long slippery slope.

Pfizer lost exclusivity on Lipitor and Xalatan last year, and Geodon this year, and Detrol's next in line come September. Pfizer has a pipeline full of clinical trials, and will attempt to lessen the pain by selling its own generic version of Lipitor, but there's no assurance that will curb any of Pfizer's upcoming pain.

What's nextNow for the $64,000 question: What's next for Merck? The answer depends on how successful Merck is at getting the majority of its new drug applications approved by the FDA, whether it can continue to attract investors with dividend increases, and how well it promotes its diabetes portfolio (which I feel is the key to its success).

Our very own CAPS community gives the company a four-star rating (out of five), with a whopping 93% of members expecting it to outperform. Consider me among the bulls, as my CAPScall of outperform on Merck is currently up 15 points.

Big pharma is a sector I examine often, yet Merck is the only one of the group I've given an outperform rating to. Merck's patent expirations are much further down the road than many of its peers, and it has a class of drugs now that can step up and fill the void of what few expirations it is dealing with. Merck doesn't need to buy its way into growth like its competitors which I think is a sign that further dividend hikes could be on their way.

Merck clearly has a pipeline that's changing lives. If you'd like the inside scoop on a stock our Motley Fool Rule Breakers team feels could offer the next revolutionary product, then click here for your free access to our latest report.

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Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.Motley Fool newsletter services have recommended buying shares of Pfizer. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.